Mortgage Interest Deduction Denied by IRS

James Jackson claimed Schedule A deduction for mortgage interest expense.  IRS denied the deduction.  Tax Court agreed with IRS.

Mr. Jackson’s girlfriend, Julie, obtained a loan and purchased a residence back in 2005.  Only Julie’s name was on the loan and the property’s title.  Mr. Jackson was unable to join Julie on the loan because he had personal debt problems.

Mr. Jackson claimed a little over $15,000 of interest expense while the 1098 issued to Julie showed almost $2,000 less. He testified that he gave Julie $1,000 in cash every month for each year under examination.  He produced a letter from Julie that stated he had given her this cash every month for the past 10 years.  He also testified that Julie paid all real estate taxes and insurance on the home. The Court rejected Mr. Jackson’s argument that Nevada’s community property laws as it relates to domestic partners gave him ownership.

IRS denied the deduction stating Mr. Jackson was not liable for the debt and therefore not allowed the deduction.  Tax Court ruled in favor of IRS.

One key we see in this case is included in the Court’s reasoning.  It specifically mentioned regulation 1.163-1(b) which states, in part, “interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness.”  The key in this phrase is the words “or equitable owner”.  This has been interpreted by the Court as saying, briefly, that a taxpayer whose name is not on the loan and/or the title may still be able to deduct the interest the taxpayer paid AS LONG AS the taxpayer is an equitable owner.  An equitable owner is someone who has the burdens and benefits of ownership of the property.  This can be shown to exist when the taxpayer can prove he/she:

1) Has the right to possess the property and to enjoy its use, rents, or profits,
2) Has a duty to maintain the property,
3) Is responsible for insuring the property,
4) Bears the property’s risk of loss,
5) Is obligated to pay the property’s taxes, assessments, or charges,
6) Has the right to improve the property without the owner’s consent, and
7) Has the right to obtain legal title at any time by paying the balance of the purchase price.
Mr. Jackson did not prove any of the above items.

The Court’s decision refers to other cases for and against this equitable ownership position.  Reading this case and the others it refers may be helpful if you have a situation where “equitable ownership” may be an issue.

Side note – Mr. Jackson claimed the mortgage interest expense on line 10 of Schedule A, which may be the reason the return was selected for examination.  Line 10 is where deductible mortgage interest expense is reported if the taxpayer has received a Form 1098 in his/her name and SSN.  Since the 1098 issued in connection with Mr. Jackson’s residence was issued to Julie in her SSN, there was a mismatch IRS found in connection with Mr. Jackson’s return.  Line 11 is where deductible mortgage interest expense is reported when the taxpayer has NOT received a Form 1098 in his/her name and SSN.

James David Jackson, TC Summary 2016-33

This text has been shared with you courtesy of:  David & Mary Mellem, EAs & Ashwaubenon Tax Professionals, 920-496-1065 (920-496-9111).